Dr. Karina Doorley:

I thank the Chair for the invitation to the ESRI to appear before the committee. I am joined by my colleagues, Dr. Muireann Lynch, Dr. Kieran McQuinn and Ms Wendy Disch. We are grateful for the opportunity to appear before the committee today to provide our views on budget 2023 and additional one-off measures for 2022. Despite unprecedented uncertainty in the global economy, both domestic and international sources of growth have demonstrated a certain degree of resilience this year. We expect modified domestic demand to register positive growth in 2022 and 2023 of 4.4% and 3.7%. The relatively strong performance of the domestic economy this year is particularly evident in the labour market and the Government Exchequer returns. Unemployment is now set to reach 4% by the end of the year, while tax receipts are increasing across all the main headings. Over the winter there is a possibility that energy costs will increase putting significant pressure on many households. Government may decide to provide further support to households most affected. This could result in significantly greater Government expenditure in 2023 than is now forecast.

Based on the significant increases in tax receipts and likely trends in expenditure observed for the year to date, we now believe the public finances will witness a surplus in the general government balance, GGB, of 0.5% of GDP in 2022. In 2023, we believe the Government will run a more modest surplus. However, that forecast could be revised in light of developments in international energy markets.

Developments in global inflationary pressures have contributed to significant downward revisions in global output and are likely to continue to feed through into domestic prices. Inflation in Ireland and the euro area stood at 9.1% and 8.9% respectively in July. Food and energy are the areas experiencing the most acute inflation globally and in Ireland. Increases in the cost of food and energy items have accelerated rapidly over the past year reaching a high point of 28.6% per annum in June 2022. Despite signs that food and energy related price growth may be slowing, prices of non-food and energy items have continued to increase. As of July 2022 prices of these items had increased 6% on an annual basis suggesting that inflation is becoming more broadly based.

Due to differences in the composition of household expenditure, inflationary pressures are heterogeneous across households. The lowest income households experienced inflation just above 10% in June. Contributions of food and energy costs are largely responsible for the varying rates of inflation. When budget 2022 was announced inflationary forecasts for 2022 ranged between 2.2% and 2.9%. Most tax and benefit parameters were increased by factors in the region of this projected inflation rate. This would have left most households no worse off in real terms had projections for inflation been correct. However, inflation has far exceeded these forecasts over the course of 2022, averaging 7.2%. A number of extra policy measures were introduced this year to help households with rising inflation. These have resulted in average household income gains of around 1.5% of disposable income, with higher gains for lower-income households. Some households may also have benefited from wage increases this year, although low income and elderly households, which contain fewer earners on average, will benefit less from this development.

One option available to policymakers to compensate households for rising inflation is indexation of the tax and welfare system. Indexing tax and benefit parameters in line with price growth would keep the purchasing power of households that are reliant on welfare constant and reduce the tax paid by working households. Indexation in line with wage growth would keep the distribution of income constant and reduce the incidence of households losing eligibility for social welfare because of inflation-driven wage increases.

Indexation leaves less scope for targeted measures. Given prospects for sustained high levels of inflation, policymakers may wish to consider greater targeting of measures to limit the cost of future supports and the risks of fuelling further inflation. Increases to welfare payments and lump-sum payments like the electricity credit are well targeted at those most affected by inflation. These types of measures have advantages over indirect tax cuts on energy as they do not disincentivise investment in energy-saving technology. Measures to specifically target low-income earning households could include the expansion of the working family payment and increases in the exemption limits for PRSI and the universal social charge, USC. Broader based tax cuts would benefit middle and higher income households.

The existence of windfall gains in energy markets and their taxation has been raised in the context of record energy prices. The majority of the windfall gains currently being made in the global energy sector accrue to fossil fuel companies. In Ireland, fossil fuel extraction is limited to the Corrib gas field which is small and dwindling. Any potential windfall gains are therefore limited to non-gas fired generation in the electricity sector. Estimating the magnitude of this windfall gain is challenging and the potential gain from a windfall tax is also difficult to estimate. There is evidence that some energy companies are using greater than expected profits on the generation side to offset losses on the supply side, which puts downward pressure on customer prices. Taxing windfall gains in the generation sector might only place some upward pressure on consumer prices.

Energy security continues to be a concern with the electricity supply, in particular, coming under pressure this winter and next. Balancing net demand with supply in real time will be increasingly challenging and may only be possible with active participation from the demand side. The prospect of further reductions or a complete shutdown of Russian gas to Europe remains a possibility which may result in gas rationing across Europe. Despite the fact that Ireland does not source gas directly from Russia, curtailment of supply across Europe may result in the need for rationing. In this case gas-fired electricity generators would be prioritised in order to avoid further pressure on electricity supplies. Large industrial gas users would be first to see their gas supply reduced before any impact on households and small businesses.

Despite significant uncertainties in the global economy, the Irish economy is in a relatively strong position in the run-up to budget 2023. This affords the opportunity for some targeted spending to mitigate some of the impact of inflation on those worst affected by it. However, the Government must take care to ensure that any package that is adopted minimises the possibility of additionally stimulating the inflationary pressures which are present.